“The $1.6 Trillion ‘Back Mountain’ Covenant”

By Travis Johnson, Stock Gumshoe, February 8, 2010

Today’s ad comes rolling in from Zachary Scheidt for his New Growth Investor newsletter from Taipan, trumpeting the huge profits to come from the secretive “Back Mountain Covenant” that will allow Europe to break the Russian chokehold on natural gas.

The teaser ad is a long one, of course — “short and sweet” rarely plays well in teaser-land, I guess, and it begins with the back story that most of us have probably heard — a large portion of the natural gas for Western Europe comes from Russia (at least 25%), and most of that comes through the Ukraine. Russia/Ukraine relations have been strained in recent years (though the recent Ukrainian election will probably thaw relations), which has led to Gazprom, the Russian gas company that’s effectively state-controlled (though you can buy shares too, if you like) cutting off gas supplies to the Ukrainian pipelines a few times, and effectively leaving much of Europe cold and dark for a week or two during these disputes.

So the basic result is that Europe, particularly Western Europe, is desperate to break Russia’s gas-fueled influence. They’ve tried building other pipelines that bypass Russia or Ukraine (also part of the Georgia problems a couple years back), and they’ve tried importing more Liquefied Natural Gas like the Asian tigers do, and they’ve tried to extend their reach into Algeria and elsewhere in Africa where new reserves are being identified. But the main part of the teaser focuses on this secretive “Back Mountain” deal that some “EU officials” made with a US gas company to help exploit their shale gas reserves.

You see, the assumption is that Europe is probably sitting on some huge shale gas fields not unlike those that have led to a gas glut in the US — the Barnett Shale, Fayetteville Shale and a few other major shale gas areas where new techniques are making extraction possible and profitable, even at lower prices. And of course, the Marcellus shale, part of which sits under Back Mountain in Pennsylvania.

Here’s the story he spins to begin the tale:

“Just weeks ago an attaché representing a consortium of European Union officials boarded a private jet bound for an undisclosed location…

“You won’t be able to find the details of this trip reported in the popular press…

“Even the mainstream media glossed over the serious potential of the trip…

“They were in a race to stop what could be a long, deadly winter in Western Europe.

“After 10 hours in the air – and a tricky landing in windy Harrisburg – the grim-faced emissary traveled two more hours via limousine over winding mountain roads.

“His destination: A barren, high-country valley in the shadow of northern Pennsylvania’s Back Mountain.

“Here, the dark-suited envoy was seen shaking hands with an American in a hard hat and muddy boots, standing on a gravel road outside a temporary trailer.

“They were sealing a deal that could pay you generous royalties over the next 20 years – potentially as much as six figures every year.

“Without fanfare, the courier placed a briefcase on the hood of a beat-up Chevy Suburban. From it, he withdrew a plain manila envelope…

“Inside was a cashier’s check for $2 billion, endorsed by a top-level EU official.”

So that’s the “deal” that’s teased here, with a US company the party that’s receiving that $2 billion … and Scheidt claims that there’s some “fine print” as well:

“But in the unreported fine print, the “Covenant” could give this American company a stake in an untapped energy discovery in Western Europe worth as much as an estimated $1.6 trillion.

“It’s the biggest cooperative energy agreement ever inked — and it could change the face of global macro-politics forever.”

So that “fine print” may well be a bit squishier — but it seems to me that this must be all about Chesapeake Energy (CHK) and their deals with European energy companies — the $2 billion one was a sale of some of CHK’s interests in the Barnett Shale to Total (TOT), the French oil and gas company, but they actually have a larger joint venture deal in place with Statoil (STO), the Norwegian energy giant. Chesapeake sold an interest (roughly 1/3) in their Marcellus Shale projects to Statoil and set up a joint venture with them to look for shale gas elsewhere in the world … one assumes their targets are largely in Europe, where ExxonMobil and ConocoPhillips are accumulating exploration acreage (Poland and Germany, mostly), but I expect they’re looking widely abroad as well, especially given their need for infrastructure and friendly locals and laws. Their deal with Total also has them looking for joint-venture work in other shale plays, too, probably in the Eagle Ford Shale in South Texas, and in a few places in Canada.

And Chesapeake does pay a dividend, albeit a small one, so this deal could bring in cash for you four times a year, as teased — the annual yield is just over 1% at the moment. I haven’t dug deeper into this one to see if there are alternative royalty stream payments on Chesapeake’s positions that would yield higher returns, or if you might be better off with their convertible bonds (as teased by Elliott Gue a while back, for one), so it’s possible that there’s a higher income play in here somewhere, too … and there are certainly some high income plays in the Marcellus Shale, they just tend to be smaller operators like the various Atlas MLPs (not that I’m particularly fond of those, just an example).

I liked Chesapeake a lot more a few years ago, I must admit, but Aubrey McClendon’s firm still has plenty of fans in the investment world. His management swagger lost a bit of luster in my eyes when he got margin calls and had to do some pretty shady stuff, like sell his antique map collection to his company for millions back when the financial crisis was felling titans everywhere. Still, despite some tough times — and these deals with Total and StatoilHydro that are, at least to some extent, a sign of a company going begging for financing — Chesapeake does have some huge shale gas acreage, and they seem to know what they’re doing. I don’t know if this would be my favorite gas play, but it is one of the larger shale gas plays and, thanks to their active deal-making over the past few months, and the media-friendliness of McClendon, they will probably continue to get a lot of attention. Whether that makes you millions in the years to come as shale gas in France, Poland and Germany gets developed by their joint venture deals is, of course, a long way from being decided. The story of European gas players looking to US shale, or to get horizontal drilling or “fracking” expertise from US companies, is certainly not a new one — much the same territory was covered by an AP article about a year ago, to give just one example.

And just as a little bonus, Scheidt also teased a second idea in this ad — this one a potential 90% gainer in a matter of days due to takeover speculation. Here’s how he pitches it:

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“How You Could Make 90% in One Day

“Europe’s energy future is in the shale gas sitting underneath places like Poland, Hungary and Austria.

“But the energy they need right away is in Texas.

“Specifically in lightly populated La Salle County, an area better known for its cattle than their natural resources.

“Until last fall, that is…

“That’s when the south Texas area not far from Mexico and the Gulf Coast caught the attention of some of the largest oil and gas companies in the world.

“Like Exxon Mobil, British Petroleum and Royal Dutch Shell, to name a few.

“Their attention was grabbed by this line in the San Antonio Express-News: ‘A small oil and gas company in Houston quietly announced the discovery of a mammoth natural gas field in south Texas…’

“One of the first wells drilled on this company’s 210,000 acres is already producing 9.1 million cubic feet of natural gas per day.

“Eager to increase their reserves, major companies in both Europe and the United States are circling the small Houston-based company that made the discovery like vultures, ready to pay a high price for their assets.

“When they make their inevitable acquisition move, you could make 90% gains in one day….

“While they are paying large fees to start fracking as soon as possible — EU officials are also willing to pay a hefty price to bring in natural gas right now, this winter.

“That’s where the newest American shale discovery comes in….

“While this south Texas discovery is a cheaper alternative for Europe than other U.S. shale plays, it’s still a lucrative opportunity for the company involved.

“So while most U.S. natural gas companies have slowed down work, this small Houston outfit has stepped up production.

“And that’s why the big boys have started moving in, looking for a way to turn the south Texas shale into their own cash cow.

“As The Wall Street Journal reported, ‘Attracted by the allure of U.S. shale gas, several major oil companies have shown interest’ in this under-the-radar company.

“This shale play ‘remains one of the hottest prospects in North America and energy companies are moving forward there even as they’re pulling back elsewhere,’ according to the San Antonio Express-News.

“Royal Dutch Shell, British Petroleum — even ExxonMobil — are all rumored to be preparing bids. An acquisition could come at any time.”

So who is this little “bonus pick?” It’s a stock we’ve heard from a few times in the last year or two, Petrohawk Energy (HK). There has certainly been takeover speculation regarding their big acreage in south Texas, which is, though Scheidt doesn’t mention it, that Eagle Ford Shale area — here’s an interview with the CEO from December claiming that he’s not eager to be bought out at current prices. Petrohawk is also one of the companies that saw some significant changes to their books with the new reserves accounting rules, one of the Motley Fool writers covers that angle much better than I could and he shared some comments on HK here. (Several of the Fool newsletters, by the way, have also picked Chesapeake in the past).

That’s all I’ve got to share on our shale gas plays for the moment — what do you think? Ready to trust Chesapeake again? Intrigued by the short-term potential of Petrohawk? Let us know with a comment below.

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